Fed Policy 101

The job of the Fed is not easy. The tools they have are crude. Predicting the future is hard. The economy is complex and the tools used may have varying impact. Markets themselves often undo policy lever influences or accelerate policy moves in an undesired way Fiscal policy can be highly influential either accentuating or directly counteracting monetary policy stance. Perhaps less relevant for the Fed than other CB's ROW fiscal and monetary policies and needs and desires of global markets can enhance or counteract Fed objectives

An equity security of a corporation values the market value of assets - the market value of liabilities 101

At every moment this equation holds true. So what to do about it.

Mostly one should ignore as market participants are pretty good in aggregate of making this estimate However when you look at a particular company transparency matters. Financial accounting doesn't tell us the MV of assets or liabilities for almost all corporations. It tells us the Book Value of the assets, liabilities and equity

Does cash want assets or do assets want cash 101 - Part 2

At the end of part 1 we dropped this cliffhanger that fear/greed "value" investing and long or short margin calls don't need cash on the sidelines to act. That is because when banks are healthy they can create money out Of thin air to allow risk takers to take risk.

So part 2 really doesn't need to even deal with the size or rate of interest of cash on the
Sidelines. These next 3 drivers don't depend on it. However they do depend on bank health. But let's not jump the gun to that point yet

Does cash want assets or do assets want cash 101

A few days ago I wrote this thread on "Cash on the Sidelines" it debunked the idea that cash can be transformed into asset purchases. The bigger question will be the topic of this thread

https://twitter.com/dampedspring/status/1857433676058853545

Remember cash grows based on three primary factors
1. Banks create money out of thin air
2. Federal reserve buys assets (QE) and government spends
3. Federal reserve pays interest on reserves and RRP Balances.

Credit spreads are not tightening as much as you may think - 101

One way of measuring value in corporate bonds is to compare their yield to a treasury bond of similar maturity. When doing this credit spreads have fallen all year and are at historic tights. BUT this is deceptive To arbitrage a corporate bond which one presumably would want to short because of TOO tight spreads which provide too little compensation for default one has to hedge the duration of the corporate bond.

Cash on the sidelines 101

Today news articles are reporting that Money Market Mutual Fund assets have grown to over 7TN

That is a fact.

The problem is those who interpret this "cash on the sidelines" as a bullish (or bearish but that's never said) signal because it represents future demand for stocks, bonds, gold or crypto.

In this thread I will try to explain why cash has grown and how it could continue to grow or shrink

BUT also how it mechanically cannot go down because those in cash want to own assets

Lastly how investor preferences

Currency markets 101
I find this to be the most difficult market to understand and don't have all of the answers on what causes currencies to move. So treat this as a work in progress

Two private sector actors exchange currency for two primary reasons A person may need a certain currency to pay a provider of a good or service, or to pay an owner of a financial asset denominated in a particular currency the going price.

The other side of the currency transaction may have a similar transaction to do as well and when that

End the Fed 101

This slogan is one of the shinier objects in the post election pre inauguration period we are in today. While such a monumental shift as completely eliminating the Fed and replacing it with nothing is unlikely to happen it's
worth examining the consequences. Firstly having a central bank is absolutely a choice. A government makes this choice and can choose to eliminate it as well.

While the effectiveness of the Fed in using its various tools is worth of separate debate that's not what this thread is about. Also while the

Making a valuable call in markets 101

Let's start with my long term basic point that should be where you stop reading this thread and go about building your wealth through your profession.

Owning a long only diversified portfolio of assets (what I call beta) is free money And should be your ONLY investment strategy to build your savings

That is MY CALL. It will always be my call and anything I write on Twitter or at DampedSpring or 2GrayBeards is an order of magnitude LESS important that this CALL

Why? Because any deviation from this plan

Decomposing a change in nominal yields 101

Today at the FOMC press conference Jay Powell mentioned decomposition. The goal of decomposition is to attribute the changes in nominal yields to isolate economic drivers. As he said there are lots of models. This 🧵is not meant to provide a model but to provide the concepts that need to be balanced when doing such modeling. The questions that people are trying to answer start with a few basics.

What does the change in yield mean to changes in growth expectations and to changes in inflation expectations

Digital events 101 what's priced in?

Let's keep it simple. Narrow the event today as either Harris or Trump. I know it's more complicated and that's not the point of this thread.

Every tradeable asset or currency has "priced" the markets expected outcome of the election The pricing is of the form
Expected move if Red* probability of Red + expected move if Blue*probability of Blue=0

This form of digital is more complicated than a money line bet on sports because the payoff is unknown as it is captured by the unknown expected move

Interest Rate Swaps and swap spreads 101

IRS are by far the largest class of derivatives in notional on planet. Reasonable estimates of notional are 400-500 TN. Or roughly 10x the global government bond market notional on which they mostly reference. Most IRS are simple vanilla agreements between two entities (they may be intermediated and cleared by third parties and exchanges but that's not worth delving into in this thread)
The agreement is simple. The "Payer" of the swap pays a fixed "coupon" to the "Receiver"

r*, Trough interest rate priced in markets, neutral fed funds rate. What are these things and what do they mean? 101

All three of these interest rates are meant to represent the overnight interest rate or fed funds and the practical rate SOFR

r* and Neutral Fed Funds rate are Both theoretical. Trough interest rate priced into markets is the expected low of Fed funds during a cutting cycle. It is a directly observable rate from market pricing BUT it is not the neutral fed funds rate and it certainly isn't r*

I listened to this

with an open mind. Here are my notes. With a 🧵

His comment that index vol supply creates volatility in single names is false. It may create low correlation but not demand for single stock options.player.captivate.fm/episode/9a7281… He uses the 2017 example despite its lack of similarity on a macro and for that matter the options market both structure products volume and ODTE

We agree on vol supply and the two side nature of ODTE which pins most of the time but is a fragility. Completely agree on that.

Rebalance transaction costs 101🧵

$XLK $AAPL $NVDA. On 6/21
At the close XLK shareholders sold 10BN of AAPL and Bought 10BN of NVDA. These are rough numbers and assumes
the fund did absolutely nothing to defray their costs by self frontrunning the trade. Did they have alpha? The fund is roughly 60BN in AUM. Why did they trade two stocks in and out that in total were 1/3 of its AUM? Simple. They had to. The fund had rules and methodologies that require the rebalance. They aren't betting on one stock vs the other. They have no alpha. Thus the trade

Over the next two years sizeable deficits and the last 750BN of QT will require the Treasury to issue around 3.75 BN of new securities and I expect 25% of that will be in Bills. Many have asked me why not more bills or even 100% bills. Here's a 100% Bills 101 In the chart above notice bills and floating rate note outstanding today as a percent of public debt is roughly 25% and I expect it to remain there as new money is borrowed with 25% bills and FRN's. But forget that for now. Let's deal with a hypothetical. Could the treasury

Selling 1 Month IV 101
There are some on here that say selling vol at the lows or at the highs are better than selling vol in the middle. Using the entire data set since VIX was created shows what you might expect 1. Selling vol is a risk premium collection strategy with a high negative convexity. Similar in outcome to buying corporate bonds

2. It doesn't really matter much what level you sell (except in a statistically insignificant portion where VIX is below 10 - dont sell degens)

My experience in the early days of HFT A story.

In 1995 the best new hire I ever made in my career invented a high frequency trading statistical arbitrage model that traded every stock in the SPX. We put it to work in markets. It was phenomenal 5ish sharp ratio but unscaleable We were paying bid offer spread. This was before electronic zero commission retail trading. We were at Salomon Brothers pre merger with Smith Barney and had no retail order flow. We also had a huge commitment to Nasdaq and Listef Block trading with most of the senior management

The greatest trade I ever was involved with and didn't do
a story

This story includes Buffett, Bridgewater, Flash Crash, and equity puts/vol. it's a doozy.

On 5/3/2010, after decades of trading equity, bond and option products I joined Bridgewater and became macro focused. Three days later the Flash Crash occurred. Stocks fell almost 10% in minutes. In all my other jobs this would have been a fire alarm with massive activity. At Bridgewater all my colleagues were not even really aware of what was happening. It's a very different place.

Gonna state my opinion on risk that the "vol selling products" blow up and cause a volmaggedon outcome. Tl;dr I don't thinks so.

As far as I can tell the gross majority of the AUM in ETN's are hedging products. JHEQX is a long equity short call long out spread structure QYLD is a buy write product on QQQ. Those are the two biggest. Both of them sell calls and so are "short vol". What if vol goes up? The call price goes up all else be equal and the structure has a drawdown. Of course all else isn't equal

Alpha and Beta Investing 201. The investment strategy I use is to allocate risk to both Alpha and Beta. For simplicity I will use DS Alpha and DS Beta for this thread though I personally use DS smart beta and less or not ETF's. The DS AlphaBeta is purple To construct this portfolio I take $100 of cash and buy $100 of DS Beta. Then as you know I buy or sell options and options spreads such that at any time my worst case loss (and hence my broker margin) is $10 maximum. That is easy to do in any form of margin account